Level 5 Economics

Economic Principles

Topic 2: Price Mechanism: Demand & Supply

Economic Environment

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1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

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ge p

rice

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not adjusted for inflation source: Statistics New Zealand (Infoshare)

Price of a pack of Eggs in NZ that was $5.00 in June-2012

New Zealand is a modern market economy

New Zealand was a traditional economy

• c.1250 to 1500– traditional unsustainable economy of abundance

• Maori settlers arrived from Cook Islands• lived in coastal areas as seal and moa hunters• self-sufficient nomadic tribes (iwi) and sub-tribes (hapu)• collective (ie joint, not private) property ownership• resource allocation decisions made by councils of chiefs• main source of protein food became extinct

• c.1500 to 1815– traditional sustainable economy of scarcity

• harvesting of kai-moana (eg fish), birds, kumara, fern• barter exchange (utu) between tribes [ note textbook ch. 15]

• intense rivalry between tribes due to resource scarcity

ref fig 2.1

transition to market economy• 1815-1850

– expansion of food supply: pigs and potatoes– trade: British, Europeans, Australians, Americans

• muskets (guns) desired on account of iwi-rivalry• exported goods/services for consumer/capital goods

– national sovereignty from 1840• Treaty of Waitangi between British crown and many Iwi

– growing settler markets for Maori goods and services• Maori market gardeners; eg Waiheke Island• flour milling and coastal shipping• international trade, especially through Sydney

– conflict over property rights; especially re land

Understanding Markets: Prices and Quantities

• Prices in a competitive market are determined by that market as a whole– prices of goods and services are determined by

the interaction of many buyers' demand andmany sellers' supply for those products.

• Prices determine the quantity demanded of a good and also its quantity supplied– quantities, unlike prices, are determined by

individual buyers and individual sellers

Demand and Supply in graphical form• Each represented as a straight line or curve

Demand "Curve" Supply "Curve"

• Quantity (Q) is a function of price (P)– If early economists were better mathematicians,

Q would be on the "y-axis" and P on the "x-axis" !!– Quantity depends on Price (and other things)– Price is the information that makes markets work

DP

Q

SP

Q

Demand• We want goods and services (products) that

give us happiness ("utility")• We demand products that we want if we are

prepared to pay a price for them– this means a willingness and an ability to give up

something else; to incur an opportunity cost

• Demand is a set of quantities matched to different prices– individual demand (principle of diminishing utility)– collective (ie market) demand curves

• sum of all individual demand curves (text Fig 3.5)

Exercise

Law of diminishing marginal utilityeach of us is willing to pay a higher price for the first item (ie unit) of something because that usually gives more happiness than subsequent items

Henry gets $6 worth of utility from eating 3 chocolate bars.He gets $6.50 worth of utility from 4 chocolate bars.• What is Henry’s marginal utility from the

consumption of the 4th chocolate bar?• If the price of is 55 cents per bar, how many will

Henry buy?

Quantity Demanded versus (vs.) Demand• a rise in the price of a good generates a left

movement along the market demand curve for that product

• this is a decrease in quantity demanded (fig)– this is not a decrease in demand– our desire for something, and our willingness to

give up something for it, is not affected by its actual price

• Quantity demanded is one point on the demand curve– Demand is the whole curve.

exercise on the difference between demand and quantity demanded

• In Carinthia and California, the people have a similar standard of living and they like apples to an equal extent.– Therefore there is no difference in the demand for

apples in Carinthia and California.

• In Carinthia the price of apples is high, whereas in California, the price is low.– In which place are more apples demanded?– California

fig

P Carinthia

P California

Carinthia California

Demand for Apples

(average per person)

Difference in price only ie no demand shift.

Q Q

Law of Market Demand• Individuals buy less of a product the higher

its price, ceteris paribus • what is true for each consumer is true for all

consumers combined• the higher the price of a good the lower

the quantity demanded––––––––––––

• Demand is all the different quantities of a good or service that people would buy at different prices.

Shifts of Demand Curve (eg Increased Demand)

• causes of increases in quantity demanded for a good, other than a change in its price– increased aggregate (ie total) income (Y)

• causes an increase in demand for most goods/services

– increased population• causes an increase in demand for some goods/services

– increased consumer preference for something• may be influenced by information, advertising, climate

– expectations of a future price increase– changing prices of related products

• increased price of a substitute product• decreased price of a complementary product

Bacon and

Eggs?

DP

Q

D'

Increased Demand

say "D prime"

1 ‘Demand’ is a relationship between: a price and income; c income and quantity demanded; b price and quantity demanded; d income and quantity supplied. 2 The market demand for any commodity is the: a total requirement for it in any given place. b amount consumers plan to buy at any given price. c total need for it calculated as an opportunity cost. d quantity needed to maintain a given standard of living. 3 The law of demand is that: a an increase in the market price always causes the quantity demanded to increase. b an increase in the market price almost always causes the quantity demanded to increase, ceteris paribus c a lower market price always means that the quantity demanded will be higher. d a lower market price almost always means that the quantity demanded will be higher, all other things being unchanged

4 A demand curve satisfying the law of demand must have a slope that a is negative. c equals +1. b is positive. d equals -1. 5 Downward-sloping demand: a is an economic law which holds without exception. b implies purchases of a product decrease with increases in income. c implies fewer purchases of a product are made as its price rises,

ceteris paribus. d implies increased demand with increased income, other things being unchanged.

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continue with Q6 and Q7

Giffen Goods

6 According to the substitution effect, a price rise, which reduces quantity demanded, causes a consumer real incomes to fall. b consumers to substitute leisure for work. c consumers to feel poorer. d consumers to switch their spending to competing goods.

7 If peas and beans are substitute goods, a typical consumer, in response to a rise in the price of peas, will: a spend more on peas and less on beans. c buy more peas and fewer beans. b buy more beans and fewer peas. d stop eating vegetables.

8 Upward-sloping supply means: a if production costs increase, suppliers will insist on a higher price. b suppliers must reduce their prices when trying to sell larger quantities. c if a commodity’s price falls, buyers will normally increase their purchases. d if price were to rise, suppliers will offer more for sale than previously.

9 The market for a commodity is said to be in equilibrium when: a the amount bought by consumers equals the amount sold by producers. b the amount consumers wish to buy at a given price equals the amount that producers wish to supply at that price. c all producers are satisfied with the price at which they can sell goods. d all consumers are satisfied with the price at which they can buy goods.

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1. Which (of peas or beans) experiences a change of demand ?

2. Which experiences a change inquantity demanded only?

Supply: Production and Distribution• firms (companies, businesses) each produce

goods and services that give them revenue– revenue gives them profits

• firms hire resources (factor inputs, eg labour) and buy material inputs (eg raw materials)– inputs are transformed (eg manufactured)

into outputs– this is the 'supply chain'

• distribution is the chain of services that bring goods/services to consumers– eg transport, finance, retail, communication

Supply Curve• Firms have individual supply schedules. (3.11)

• Market supply schedules (& curves) are the sum of individual firms' supply schedules.

• The quantity supplied (Qs) (ie producedfor sale) of a particular product is a function of the price of that product.– represented as a single position on a supply curve– an increase in price signals an increase in Qs (3.12

)– quite different to an increase in supply (fig 3.12b)

• an increase in supply is a shift right of a supply curve• a shift right; not a shift up !!

SP

Q

S'

Increased Supply

say "S prime"

Law of Market Supply

• ceteris paribus, the higher the price of a good the higher the quantity supplied

––––––––––––• Supply is all the different quantities of a

good or service that firms would produce for sale at different prices.

Shifts of Supply Curve (eg Increased Supply fig 3.12)

• causes of increases in quantity supplied for a good, other than a change in its price– increased productivity

• for example, more eggs per hen (female chicken)• may arise from improved technology or better climate

– decreased costs• for example, lower price of hens' food• could be reduced wages

– changes in prices of related goods• for example, a fall in the price of chicken meat

– increased expectation of future price increases• supply less today

– in the long run, higher profits mean more firms

use Eggs as example

Price Determination: Market Equilibrium• Markets clear when QD equals QS.

– no unsold goods– no shortages– equilibrium quantity Qe

• Equilibrium Price (text 3.13)– the price for which markets clear

• plans of buyers and sellers balance

– at this price there is not• excess supply (QS > QD ) (QS is not greater than QD)• excess demand (QD > QS ) (QD is not greater than QS)

• Adjustment to Equilibrium (text 3.14)

3

P

QQS QD

Correction of a Shortage

P0

P1

6 According to the substitution effect, a price rise, which reduces quantity demanded, causes: a consumer real incomes to fall. b consumers to substitute leisure for work. c consumers to feel poorer. d consumers to switch their spending to competing goods.

7 If peas and beans are substitute goods a typical consumer, in response to a the price of peas, will: a spend more on peas and less on beans. c buy more peas and fe b buy more beans and fewer peas. d stop eating vegetables.

8 Upward-sloping supply means: a if production costs increase, suppliers will insist on a higher price. b suppliers must reduce their prices when trying to sell larger quantities. c if a commodity’s price falls, buyers will normally increase their purchases. d if price were to rise, suppliers will offer more for sale than previously.

9 The market for a commodity is said to be in equilibrium when: a the amount bought by consumers equals the amount sold by producers. b the amount consumers wish to buy at a given price equals the amount that producers wish to supply at that price. c all producers are satisfied with the price at which they can sell goods. d all consumers ar e satisfied with the price at which they can buy goods.

previousnext

please continue with next 3 questions

1 When the market price is above the equilibrium level:

a a shortage will emerge and the market price will fall. b a surplus will emerge and the market price will fall. c a shortage will emerge and the market price will rise. d a surplus will emerge and the market price will rise.

2 In a competitive market the price of a good is $5 and at that price sellers wish to sell 400 units and buyers wish to buy 300 units, then the price will tend to:

a fall below $5 and buyers wish to purchase less than 300 units. b rise above $5 and sellers to offer more than 400 units. c fall below $5 and buyers to purchase more than 300 units. d rise above $5 and suppliers to offer more than 400 units.

3 Buyers wish to buy 10,000 XJS shares at a price of $2.00 while sellers wish to sell 5,000 XJS shares at this price. Equilibrium in the market will be achieved with:

a sales of 10,000 shares at a price of $2.00. b sales of 5,000 shares at a price of $2.00. c sales of between 5,000 and 10,000 shares at a price of $2.00. d sales of between 5,000 and 10,000 shares at a price above $2.00.

previousnext

financial assets are subject to market forces (supply and demand) too

Changes to Equilibrium Prices: Shifting Curves

• A shift represents a 'disturbance' or 'shock' to a market in (or adjusting to) equilibrium.– Initially a shift induces a state of:

• excess demand, or• excess supply

• Four (4) situations: (text 3.15)– increased demand– decreased demand– increased supply– decreased supply

use Eggs as example

ck

ck

ck

ck

ck

ck

D income effect

D complement

D complement

SS

D substitute

ck

ck

D changed preference or "taste" for cars

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• minimum price controls (price floors)– lead to surpluses if Pmin > P* (text fig 3.18b; [4.7, 5e])

• maximum price controls (price ceilings)– lead to shortages if Pmax < P* (text fig 3.18a; [4.7, 5e])

• Black Markets / Scalping:– illegal markets sometimes caused by price ceilings

or other forms of under-pricing– ticket scalping (also called "touting")

Price Controls create Disequilibrium

Homework Exercises

1. Q2 S&R 67, S p.89 "Apartments"

2. Multichoice & Review Questions 1-4

You may download and print

graph paper and templates

from Moodle.

3. More Multichoice Exercises

Increase

left up

Decrease

From Fig 3.7.

P

P'

QQ'

Decrease

right down

Increase

A fall in price causes an increase in Quantity Demanded.

P'

P

Q'Q

Fig 2.10a

Increase

right up

Increase in Quantity Supplied

a 'Giffen Good' breaks the Law of Demand

Water might be a "Giffen Good" in some situations

1 P Q PQWater 2 6 12Wine 9 1 9

7 21

2 P Q PQWater 3 7 21Wine 9 0 0

7 21

in this example, there is a weekly budget constraint for drinks of $21

What if the price of water increases to $3 per bottle?

Contrast: here we see conventional substitution

1 P Q PQWater 2 9 18Wine 6 2 12

11 30

2 P Q PQWater 3 4 12Wine 6 3 18

7 30

contrast: when family can reduce total Q

in this example, there is a weekly budget constraint for drinks of $30

1 ‘Demand’ is a relationship between: a price and income; c income and quantity demanded; b price and quantity demanded; d income and quantity supplied.

2 The market demand for any commodity is the: a total requirement for it in any given place. b amount consumers plan to buy at any given price. c total need for it calculated as an opportunity cost. d quantity needed to maintain a given standard of living.

3 The law of demand is that: a an increase in the market price always causes the quantity demanded to increase. b an increase in the market price almost always causes the quantity demanded to increase, ceteris paribus. c a lower market price always means that the quantity demanded will be higher. d a lower market price almost always means that the quantity demanded will be higher, all other things being unchanged.

4 A demand curve satisfying the law of demand must have a slope that: a is negative. c equals +1. b is positive. d equals -1.

5 Downward-sloping demand: a is an economic law which holds without exception. b implies purchases of a product decrease with increases in income. c implies fewer purchases of a product are made as its price rises,

ceteris paribus. d implies increased demand with increased income, other things being unchanged.

6 According to the substitution effect , a price rise, which reduces quantity demanded, causes a consumer real incomes to fall. b consumers to substitute leisure for work. c consumers to feel poorer. d consumers to switch their spending to competing goods.

7 If peas and beans are substitute goods a typical consumer, in response to a rise in the price of peas, will: a spend more on peas and less on beans. c buy more peas and fewer beans. b buy more beans and fewer peas. d stop eating vegetables.

8 Upward -sloping supply means: a if production costs increase, suppliers will insist on a higher price. b suppliers must reduce their prices when trying to sell larger quantities. c if a commodity’s price falls, buyers will normally increase their purchases. d if price were to rise, suppliers will offer more for sale than previously.

9 The market for a commodity is said to be in equilibrium when: a the amount bought by consumers equals the amount sold by producers. b the amount consumers wish to buy at a given price equals the amount that producers wish to supply at that price. c all producers are satisfied with the price at which they can sell goods. d all consumers ar e satisfied with the price at which they can buy goods.

1 When the market price is above the equilibrium level:

a a shortage will emerge and the market price will fall. b a surplus will emerge and the market price will fall. c a shortage will emerge and the market price will rise. d a surplus will emerge and the market price will rise.

2 In a competitive market the price of a good is $5 and at that price sellers wish to sell 400 units and buyers wish to buy 300 units, then the price will tend to:

a fall below $5 and buyers wish to purchase less than 300 units. b rise above $5 and sellers to offer more than 400 units. c fall below $5 and buyers to purchase more than 300 units. d rise above $5 and suppliers to offer more than 400 units.

3 Buyers wish to buy 10,000 XJS shares at a price of $2.00 while sellers wish to sell 5,000 XJS shares at this price. Equilibrium in the market will be achieved with:

a sales of 10,000 shares at a price of $2.00. b sales of 5,000 shares at a price of $2.00. c sales of between 5,000 and 10,000 shares at a price of $2.00. d sales of between 5,000 and 10,000 shares at a price above $2.00.

Review Questions1. If the price of building timber falls,

• what will be the impact on the building timber market?• what will be the impact on the building bricks market?

2. Childcare workers get a 10% pay increase.for the following, answer Increase, Decrease, or No Change • How will this affect their demand for cameras?• How will this affect the supply of child-care services?

3. Suppose there is a shortage of agricultural machinery and a surplus of guns in the economy.How should the price mechanism ensure that allocative efficiency is achieved?

4. Explain ticket scalping at Eden Park when NZ plays Australia (solution)

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Fig 2.6

review question 1

Building Timber

Building Bricks

click for Qscalp and Pscalp

think of Eden Park: NZ vs. Australia

Ticket Scalping Example

Explain ticket scalping (also known as ticket touting) at major events such as theWorld Cup Grand Final, or a major rock concert.

Ticket scalping is kind of black market. Equilibrium market price is (or is likely to be) above official price; hence excess demand or shortage of tickets, creating an opportunity to resell at a price above the equilibrium market price.The equilibrium price is not known as each event represents a unique market

Pscalp

Qscalp

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